The Fallacy of Taking German Lessons

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The Guardian/UK

The Fallacy of Taking German Lessons

Germany is held up by deficit hawks as an ideal for other, less successful economies such as Spain's to emulate. Big mistake

Germany's economic recovery has gathered steam lately and is being used – in both the European and the US press – to promote the view that Germany "had the formula right all along" and "made the short-term sacrifices necessary for long-term success". The formula, it is argued, is one that includes the austerity policies now being shoved down the throats of countries such as Spain and Greece.

Germany certainly has got some things right, but their formula has not included pro-cyclical policies – fiscal tightening when the economy is contracting or barely growing – as the European authorities and IMF are requiring of Spain. In fact, the latest budget figures released this week show that Germany's budget deficit for the first half of this year has doubled as compared to one year ago. At 3.5% of GDP, it is still lower than that of many other European countries. But the Germans definitely did not cut their budget deficit during recession, as Spain is doing.

The policy that Germany has got most right is the one that has kept its unemployment rate (currently 7.0%) at or below pre-recession levels, despite a steeper decline in output (4.6%) for 2009 than the US experienced. This is the policy of subsidising employers to keep workers on the job at reduced hours, instead of laying them off. This has saved hundreds of thousands of jobs in Germany – and could save millions in the United States, if only we had some political leadership with the courage to take these modest but obvious steps.

Ironically, however, the reforms that Spain is being pressured to adopt are in the opposite direction – the European authorities want Spain to make it easier for employers to get rid of workers.

Another flaw in the argument: Germany's record second quarter growth – 2.2% over the previous quarter, or 9% at an annual rate – was driven mostly by exports, which grew 8.2% over the previous quarter, or 37% annualised. As the South Centre has noted, for 2002-2007, exports accounted for 143% of Germany's growth – meaning that the German economy would have actually contracted over these years if not for export growth.

Since most of Germany's exports go to Eurozone countries, it is clear that not everyone in the Eurozone can follow Germany's example, even if they had the manufacturing competitiveness to do so.

This leads us to the other issue that is raised against Spain, and in support of austerity policies there: that Spain needs lower wages in order to compete with Germany's superior manufacturing productivity. It is true that Germany's manufacturing productivity is higher than that of Spain, and the gap has increased since the adoption of the Euro in 2002. Furthermore, the gap in unit labour costs has increased even more – since wages in Spain rose faster than in Germany during this period, at the same time that Germany's productivity was growing faster than Spain's.

But as a practical matter, this is really an argument that Spain doesn't belong in the Eurozone with Germany. If Spain had its own currency, it could increase its competitiveness relative to Germany through devaluation, which would make its exports cheaper. The common currency precludes the option of devaluation.

That leaves "internal devaluation", or restoring export competitiveness through lower wages. To do this would require a deep and prolonged recession, with unemployment driven so high that it generates enormous downward pressure on wages. Latvia, which maintains a fixed exchange rate with the euro, has not got very far with this strategy, despite a world record loss of more then 25% of GDP in just two years. Estonia tried a similar strategy, losing about 20% of GDP and driving unemployment from 2% to 16%. But even this massive collective punishment has had little impact on the country's real exchange rate.

The problems associated with having a common currency among countries with widely varying productivity levels will have to be resolved in the Eurozone at some point. But they will not be resolved by imposing pro-cyclical policies on Spain or any other Eurozone country. And Germany's economic recovery does not provide any evidence in favour of such self-destructive policies.

Mark Weisbrot

Mark Weisbrot is Co-Director of the Center for Economic and Policy Research (CEPR), in Washington, DC. He is also president of Just Foreign Policy. He is co-author, with Dean Baker, of Social Security: The Phony Crisis. E-mail Mark: weisbrot@cepr.net

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